The World Price of Foreign Exchange Risk

ABSTRACT

Departures from purchasing power parity imply that different countries have different prices for goods when a common numeraire
is used. Stochastic changes in exchange rates are associated with changes in these prices and constitute additional sources
of risk in asset pricing models. This article investigates whether exchange rate risks are priced in international asset markets
using a conditional approach that allows for time variation in the rewards for exchange rate risk. The results for equities
and currencies of the world's four largest equity markets support the existence of foreign exchange risk premia.